Stocks have gone more than 400 days without a 10% drop on their way to all-time highs, and the global economy looks poised to accelerate in 2014. So it makes all the sense in the world that investors are more upbeat than they’ve been in years, doesn’t it?
A Bloomberg survey of investors shows 59% believe the global economy is improving, while more than half name stocks as their favorite asset class for 2014 even after hefty gains in 2013. As the World Economic Forum gets underway in Davos, Switzerland, the dominant emerging themes are wealth inequality and how better to distribute the world’s abundance rather than a preoccupation with systemic risks or economic crises of prior years.
This fits with the general tenor of investor mood as the year gets underway. In most measurable and observable ways, the U.S. economy has picked up some pace and is tracking toward a 3% real growth rate for this year. The Federal Reserve’s recession probability index is sitting near zero.
Overseas, Europe has nosed out of recession and Japan’s go-for-broke stimulus efforts have powered an export and consumer revival. Emerging markets have slowed and are undergoing a fitful adjustment to slightly tighter Federal Reserve policy, yet the crowd sees these economies continuing to expand this year.
This comfortable consensus that economic bullets have been dodged and policy risks defused is translating into a broadly optimistic take on financial markets. Surveys of professional investment advisors in the U.S. by Investors Intelligence show multi-decade highs in the ratio of professed bulls on stocks versus bears.
The breakdown of trading in stock options lately shows far more speculative upside bets than fearful hedging. Meantime, corporate insiders have been selling their company shares at a searing pace this year, cashing in on the surge in prices in a new tax year.
These are at least causes for cautious monitoring, even as the indisputable uptrend in stocks and other risky assets such as corporate debt appears sturdy.
In weighing such hints of the market’s mood, it’s worth asking how logical, normal optimism can be distinguished from the sort of risk-oblivious overconfidence that often leaves the market susceptible to rude shocks.
READING MARKET SENTIMENT
As Yahoo Finance’s Aaron Task and I discuss in the attached video, the game of reading sentiment cues is a tricky one to play -- and can, itself, become “too popular.” There’s a hall-of-mirrors aspect to the market conversation in which “everyone” seems to be saying that “everyone else” is too much one thing or another.
So a general wariness about believing too hard in the same thing most other investors believe seems pervasive. This produces the constant declarations of “bubbles” purportedly arising here and there, and keeps a substantial store of skepticism and anxiety right below the market surface. While this lasts, it counts as a net positive for stocks.
The monthly Bank of America Merrill Lynch global fund manager survey, released Monday, shows the pronounced and expected majority of professional investors overweighted in equities compared to bonds and commodities.
Yet Merrill global strategist Michael Hartnett notes that managers’ cash holdings remain “stubbornly high” compared to history, which should support equities. Meantime, the highest proportion of respondents since mid-2000 say that stocks are “overvalued,” hardly the sign of giddy rationalization of reckless buying at today’s levels.
There are now record levels of accumulated bets in CBOE S&P 500 Volatility Index (VIX) futures by investors bracing for a spurt higher in market jumpiness –- another sign that the prevailing cheerfulness is diluted by wariness.
One lopsided collective opinion expressed by the managers is that companies are being too conservative with their cash and are under-investing in their businesses. A record majority of fund managers in the Merrill survey say they want CEOs to use cash to boost capital spending, versus distributing it to shareholders or paying down debt.
WILL COMPANIES DEPLOY MORE CASH?
While it’s far from clear that a capex boom is imminent, the corporate sector could easily catalyze growth and equity-market value creation by deploying cash more aggressively one way or the other –- hiring, acquisitions, restructurings. Along with a “second wind” to earnings from renewed revenue growth -– of which there have been a few inklings so far this earnings season –- this could blunt the worries that stock prices have outraced fundamentals.
Since entering the New Year at an all-time high, the Standard & Poor’s 500 index (^GSPC) has churned sideways in a narrow range just below the Dec. 31 level. Yet beneath the surface, a fair amount of reshuffling has occurred.
Jonathan Krinsky, technical strategist at MKM Partners, noted Monday that while the index is off just 0.5%, four component sectors –- consumer discretionary, consumer staples, energy and telecom –- aree down 2% or more year to date. Healthcare, up nearly 3%, is the main beneficiary.
This kind of uneven sector performance can be viewed as the mark of a ragged, tired market prone to faltering or the emergence of a more selective tape. The latter kind of rotation could be just the thing that allows stocks to flow from weaker to stronger hands and burn off some of the unhelpful optimism that has infused investors’ outlook entering 2014. Krinsky, for one, is concerned about the faltering of retail stocks and thinks the S&P could retreat by a few percent from current levels. The true key to determining whether this would be a refreshing dip is how investor sentiment responds: If sentiment remains upbeat on any shallow downturn, that would probably mean the setback would need to carry stocks lower. If a wiggle lower from all-time highs gets the bears huffing loudly and anxiety flaring, it will mean the market’s fuel tank has more worry left to power it ahead.
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